Netflix Is Streaming But Studios Want Money Too

Netflix (NFLX) went public in 2002 – a video lending library with no late fees; adios to Blockbuster – and its shares bounced along nicely enough until roughly two years ago, when the stock became a rocket.

That seemed to make sense. In recent quarters, Netflix’s business has been shifting from its decidedly unsexy original model – mailing DVDs back and forth – to streaming video. That enables the instant-gratification impulse we all share. And it allows videos of movies and TV shows to be watched not just on televisions and laptops, but on mobile devices, which are rapidly growing in number.

All of a sudden, Netflix, notable for being one of the U.S. Postal Service’s best customers ($500 million-plus in postal costs a year; big snore), looked like a hot technology company. Tech investors, who at times confuse cool gadgets and services for great investments, have helped bid the stock up to an outlandish multiple.

Management, led by Reed Hastings, co-founder and CEO, seems frighteningly confident, given that Apple (AAPL), Microsoft (MSFT) and Amazon (AMZN) are all competitors in offering video-on-demand. Hastings and his board spent more than $700 million since 2007 on stock buybacks.

Keep growing the subscriber base. Keep offering them more content. So far, that’s worked out fine. At the end of the third quarter, Netflix had 16.9 million subscribers, up nearly two million during the period. And the cost of acquiring those video addicts was $19.81 each, down from $24.37 the prior quarter. Those are friendly trends.

Some other measures are less friendly, however. Average monthly revenue per subscriber, $12.12 in the third quarter, has been declining as more new customers sign up for the cheapie plans. Churn, a measure of subscriber losses expressed as a percentage of total subscribers, declined during the latest quarter. That’s good. But Neflix, like all subscription-based businesses – remember newspapers? – has to sign up a lot of new customers every quarter, and the bigger the business gets, the tougher that can be. During the third quarter, Netflix brought in 4.1 million new subscribers; defections meant the net gain in subscribers was less than two million.

The other problem for Netflix is buying the movies and TV shows to then stream to subscribers. Studios want money, too. Netflix disclosed in its third-quarter 10-Q that it had $1.2 billion in commitments to pay for streaming content, up from just $115 million at the end of last year. And it still has other content acquisition agreements to wrap up. The margins, steady in recent years, could come under pressure.

There are plenty of critics of Netflix stock, and YCharts’ proprietary valuation system rates the shares as significantly overvalued. The buybacks no doubt have helped propel the stock price – and with it the fortune of Hastings, who controls about 6% of the shares – but should Netflix get into a real dogfight with bigger players over the movie and TV streaming business, it may wish it still had all that cash.